The mining boom hangover is about to begin

I do not believe Australians fully understand the seriousness of what is happening in the global mining business. Right now it is the Australian mining investment boom that is delivering the good economic figures that Treasurer Joe Hockey boasts about. Next year and in 2016 we will see a rapid decline in mining investment and, worse still, bad news on the mining front is still emerging from many quarters. Mining will still underpin Australia but the huge investment boost is over.

Normally the changed mining outlook would see the Australian dollar slump, but because our interest rates are so above Europe and the US (and last night’s European cut underlines this), our currency stays high. This makes it even harder to justify new mining projects and intensifies the impact of the price reductions.

This amazing boom has enabled Australia to go 23 years without a recession. In the post-war decades among developed countries only the Netherlands has beaten that record and they fell over in the global financial crisis.

Chinese banking scams punctuate the mining fall. At the beginning of this calendar year we saw iron ore prices soar and many believed the boom would continue. But the spike was partly on the back of a Chinese bank trading scam where steel mills could obtain credit by buying ore they did not need. It unravelled and the price slumped.

For a long time similar Chinese banking scams have involved copper, which was used as security for apartment block building loans. The apartment blocks normally had no tenants. Now this week one of these copper banking games has proved to be a fraud where the same copper was used for many mortgages. The crazy copper game may now end. 

Longer term, copper will fare better than many other minerals, but there could be short-term pain.

For me, the full realisation that the mining boom was marching towards its end came just one day short of 17 months ago when I wrote the benchmark comment with the heading China makes a frightening energy shift. The opening said: “Register February 7, 2013 in your diary. That is the day you fully appreciated the new direction China is now taking which will hit the expansion of our coal industry and later may affect other mineral exports.”

Of course as regular readers of my commentary will recall I based those conclusions on research by Ross Garnaut and his son John Garnaut. As we now know coal prices have slumped. I was reminded of how right the Garnauts were when, in Business Spectator yesterday, we carried the heading China coal demand to fall: Garnaut.

Ross Garnaut, writing in the forthcoming China & World Economy Journal, predicts thermal coal consumption in China will fall by 0.7 per cent per annum through to 2020, leading to a “historic” turnaround in demand from a lift of 13 per cent between 2000-2011 to a 10 per cent decline through to 2020.

The essence of what Garnaut was saying in February last year was that China was about to tackle its emissions and air pollution, and coal would be the sufferer. Inevitably iron ore would also be affected. Gas, solar and perhaps nuclear would be the winners. At the time coal miners were engaged in massive, high-cost expansions and did not believe the commentary. Most do now.

Falling coal demand in China is happening as extra coal supply comes onto the market, including big expansions in Australia. In addition the swing by the US to gas, which freed up US coal from the domestic market to exports, has helped pummel the coal price. At least we had gas.

But now China has signed a massive, cut-price gas deal with Russia which will make most new Australian gas projects uneconomic and put pressure on long-term returns from the high-cost developments like Gorgon.

What happens next? It will be very hard to get new projects off the ground and while prices for iron ore and coal remain depressed, returns will be a lot lower than forecast. If PricewaterhouseCoopers is right the next step is lower dividends from many miners.

According to the Financial Times, PwC believes that:

“The level of dividends paid by the world’s largest miners is at risk amid weaker commodity prices after companies’ payouts to investors last year amounted to more than double their net profits … The aggregate profits earned by a ‘top 40’ group of the world’s biggest miners by market capitalisation were driven down by impairments and slumped more than 70 per cent in 2013 to $20 billion, the lowest level in a decade … At the same time dividends last year from the same group of companies amounted to $41bn, up from $15bn five years previously. Dividends have become an important tool for miners to try to retain investor support but in the tough times it will be hard to sustain them.”